Did you know that a fire or other casualty losses related to your rental property could affect your taxes? Floods, tornadoes, hurricanes, and other natural disasters impact many cities and properties across the US.
As global warming worsens, extreme weather events are more common. Homeowners are particularly at risk. Although most do not worry about tragedies because they're insured, the truth is that policies are not enough.
Luckily, the Internal Revenue Service (IRS) can help! Rental property owners may be able to take a casualty loss and obtain refunds for taxes paid in previous years.
Overall, insured casualty losses to rental units are tax deductible. However, landlords need to know more about these disasters' impact on their property.
Are you looking for more information about it? Here's everything you need to know. Read on!
What Is a Casualty?
Before delving into the topic, it's also important to understand this definition. A "casualty" is a damage or loss caused by an unexpected, sudden, or unusual event.
These casualties can result from different causes. However, those that are considered "deductible" may include the following:
- Sonic boom
- Government-ordered demolition of a property considered unsafe due to hazardous events
- Government relocation of a building deemed unsafe due to these events
- Storms, including tornadoes and hurricanes
- Volcanic eruptions
As you can see, all these events have something in common. They aren't predictable and happen suddenly. Therefore, you should see suddenness as the hallmark of this type of damage and loss.
In this regard, damage to rental properties that occurred progressively due to normal wear and tear, weakening, or deterioration from normal weather conditions is not deductible.
However, a casualty must not be declared a disaster by the federal government to be considered deductible when it comes to rental properties.
Additionally, these losses may also be deductible even if the event that damaged the property occurred in a federally declared disaster area.
Contrastingly, casualty losses for personal properties are deductible only if there's a presidential declaration deeming the event as a disaster.
If there is an accidental fire in an apartment building, for example, you can deduct the losses. However, it isn't the case if a fire occurs due to an error in your personal home.
Determining whether an event is a casualty loss or not may also depend on the severity of the damage. Also, not all rental properties are covered for these unfortunate, sudden, unexpected, or unusual events.
Common Examples of Casualty Loss Deduction
Taking advantage of these tax benefits can make the difference between losing money due to an unfortunate event and earning a profit on a rental unit. Therefore, landlords should be aware of the damages that may apply for casualty deduction. These are some examples:
Landlords can deduct mortgage interest payments on loans used to purchase the rental property or interest on credit cards used to pay for goods or services related to the rental unit.
The Tax Cuts and Jobs Act set a cap on interest deductions for property owners who make more than $25 million in profit from their rental units. However, landlords can avoid this limit.
In order to avoid the limits on the interest deduction, landlords must agree to depreciate their property for 30 years instead of 27.5.
Some repairs are fully deductible as long as they are regular, reasonable in cost, and necessary. Furthermore, it applies only in the year in which the repair was made.
Fixing leaks, gutters, and floors may fall into this category. The same is true for repairs related to broken windows, repainting, fixing leaks, and plastering.
Rental Real Property Depreciation
Costs for a house, apartment building, or other rental properties are not deductible in the same year that landlords pay for them.
Property owners must recover that cost through depreciation. In simple terms, the amount must be portioned and progressively deducted over several years.
If personal property is used for rental activities and there are casualty losses, landlords can deduct the costs in one year. However, they're required to use the minimis safe harbor deduction if the property costs more than $2,000.
In this category, appliances or furniture used in rental units and gardening equipment are considered "personal property" and may qualify for deductions.
Landlords are also entitled to deductions for expenses related to most of the driving they do to fulfill their rental activities.
However, it doesn't apply if the property owner must go to the property to make any improvements. In addition, there are several options when it comes to deducting these expenses.
Property owners who use an SUV, pickup, or panel truck for their rental activities can deduct repairs, gasoline, and upkeep expenses or use the standard mileage rate.
However, those who want to qualify for the standard mileage rate should check the IRS website for current rates and regulations. Also, there's a requirement: Landlords can only use it for the first year they drive a vehicle for rental activities.
If a property is used for a home office, a workshop, or another home workspace for the rental business, landlords may deduct those expenses from their taxable income. It also applies to tenants.
Employees and Independent Contractors
Landlords who hire a third party to perform services for their rental activity may deduct their wages. However, this must be done as a rental business expense.
Since this rule applies to employees and independent contractors, property owners should be aware of the tax rules that apply when hiring independent contractors.
Legal and Professional Services
A property owner may also deduct fees paid to attorneys, property management companies, advisors, accountants, or other professionals.
These deductions are considered operating expenses if they are related to the rental activity.
Landlords may also deduct the premiums paid for any type of insurance for the rental unit.
Also, if they have employees, property owners can deduct the fees paid for their health and workers' compensation insurance.
Casualty Loss Deduction: How Much Can You Deduct?
As a landlord, there's another important question to answer in these cases: how much can you deduct from taxes in case of a casualty loss?
The amount you can deduct depends on the severity of the damage, whether the property was completely or partially destroyed. If the losses were covered by insurance, the amount could also vary.
Additionally, landlords must figure out the deduction for each item in case multiple things are damaged or destroyed by a sudden event. This rule applies to rental units and land improvements performed on the property.
However, again, the regulations change slightly if the losses are personal. Landlords are not required to make separate deductions of personal property items inside a rental property. It includes appliances like refrigerators or stoves.
To calculate the amount of deductible casualty loss, landlords must consider these two scenarios:
Property to Total Loss
When a property is completely destroyed or stolen, landlords must calculate the deduction based on three elements: salvage value, adjusted basis, and insurance proceeds.
This is the formula:
Adjusted basis - salvage rules - insurance proceeds = deductible loss.
The term "adjusted basis" describes the property's original cost plus improvements value minus deductions that property owners take for regular or bonus depreciation or Section 179-related expenses.
However, property owners must always determine the basis separately. There should be a sum for the unit or building, one for landscaping, and another for improvements.
When the property is destroyed, the value of what remains there is known as "salvage value." Therefore, this sum is usually low.
Let's consider this example: if a rental property burns down completely, there may be some bricks or building materials with "salvage value" there. However, it does not apply when items are stolen.
Property a Partial Loss
When a property is only partially destroyed, the casualty loss deduction amount should be the lesser of the adjusted basis and the decrease in the unit's fair market value due to damage minus the insurance proceeds and the salvage value.
Moreover, landlords must reduce both amounts through any insurance they have received or expect to receive.
Although the fair market value measure is often less years after the unit is purchased, property owners must use that figure. As a landlord, you can also use an appraisal by a competent party to determine the decrease in fair market value and the salvage value.
As an alternative, rental property owners can also use costs for making repairs or cleaning up the partially damaged property after a casualty to measure the fair market value decrease.
However, this is only possible in the following cases:
- Repairs are necessary to bring the rental unit back to its pre-casualty condition.
- Repairs are completed before the due date for the property owner's tax return.
- Repairs are only for damages and the amount is not excessive.
- The property's value after the repairs is not greater than its value before a casualty.
It's essential to understand that repair costs are not deductible casualty losses. This sum is only used to prove that the property's market fair value has decreased.
Can Insurance Affect Tax Deductions for Casualty Losses?
As a property owner, you can also reduce the casualty loss deduction amount by insurance proceeds or other reimbursements you may receive.
However, you are not required to file an insurance claim to qualify for a casualty loss deduction if you operate a rental business or income-producing property. In fact, many landlords do not file claims to prevent the insurance company from increasing the premium or canceling the policy.
Also, when the insurance compensation is less than expected, property owners can claim a loss. It should be done the year they determine they will receive no further reimbursement.
Property owners should never amend the original return for the prior year. In addition, there are other requirements regarding the amount of income if the reimbursement is higher.
Other Factors That May Affect Tax Deduction for Casualty Losses
Landlords must also reduce their claimed loss if they received or expect to receive the following payments or services:
- Repairs costs covered by the tenant
- Forgiven federal disaster loan (any part)
- Repairs, cleanup, and restoration costs provided for free by the Red Cross or other relief agency
- Court awards for damages or theft minus attorney fees and related expenses if used to get the award
Casualty Losses in Disaster Areas
Although casualty losses are generally deductible the year they occur, there's an exception regarding disaster areas.
If the casualty loss occurred in a federally declared disaster area, property owners can deduct the loss from the previous year's taxes.
However, landlords who have already filed their returns for the prior year can claim a disaster loss against the year's income via an amended return. This applies only if it is done within six months after the original date for filing the returns.
As you can see, if you have suffered casualty and theft losses, you can deduct some of them. However, it depends on the type of property and the severity of the damage.
Need help understanding that process? Do you want to make sure your rental business is successful and know what legal resources you can use to protect your property if an unfortunate accident occurs? DoorLoop has got you covered!
We have valuable information on each state's rental laws and all the free forms you need to save time. Find more details on our website!